Apart from the price-to-earnings (P/E) ratio, another parameter that is commonly used to value stocks is price-to-book value (P/BV). But what does P/BV means and how can investors use this parameter to value their investments? In this article, we will try and simplify this concept. How is P/BV calculated?
P/BV is a valuation ratio and is arrived at by dividing the market price of a share with the respective company's book value per share. Now, book value is equal to the shareholder's equity (share capital plus reserves and surplus). Book value can also be arrived at by subtracting current liabilities and debt from total assets. For the banking and finance companies, book value is calculated as 'share capital plus reserves minus miscellaneous assets not written off. This formula then takes care of the bank's NPAs and gives a correct picture.
Liabilities | Rs m | Assets | Rs m |
Equity capital | 2,860 | Cash | 69,500 |
Reserves & surplus | 135,090 | Other current assets | 60,680 |
Current liabilities | 41,910 | Fixed assets | 47,770 |
Investments | 720 | ||
Deferred tax assets | 1,190 | ||
179,860 | 179,860 |
If one were to take a look at Infosys' consolidated balance sheet for FY08, as mentioned above, book value will be arrived at by adding Rs 2,860 m (equity capital) and Rs 135,090 m (reserves and surplus), which equals to Rs 137,950 m. Conversely, when we deduct current liabilities from total assets, we shall arrive at a similar figure. Now, by dividing this book value (Rs 137,950 m) by the issued equity shares of the company (approx 572 m), we would arrive at the book value per share figure, which is Rs 241.2. This will be our denominator for calculating the P/BV for the Infosys stock, which currently stands at 6.6x.
P/BV figures for companies in the services industries like software and FMCG are high as compared to those of companies in the sectors like auto, engineering, steel and banking. This is because companies from the sectors like software and FMCG have low amount of tangible assets (fixed assets etc.) on their books and, as such, the P/BV may not be a correct indicator of valuation. On the other hand, old economy sectors like auto and engineering have large balance sheets, i.e., they have a large amount of fixed assets and investments. As such, P/BV is a good indicator of measuring value of stocks from these sectors.
What does P/BV indicates?
P/BV is a good metric to value stocks of companies in the capital-intensive industries like engineering, automobiles and banks, which have large amount of tangible assets in their books (balance sheet). If a company is trading at a P/BV of less than 1, this indicates any or both of the two -
A high P/BV indicates vice versa, i.e., markets believe the company's assets to be undervalued or that the company is earning and is expected to earn in the future a high return on its assets. Book value also has a relationship with the 'Return on Equity' of a company. In fact, book value can also be termed as equity (equity capital plus reserves and surplus). As such, for a company that earns a high return on equity, investors would be ready to give the stock a high P/BV multiple.
What does P/BV fail to indicate?
Net worth (Rs m) | No. of shares (m) | BVPS (Rs) | CMP (Rs) | P/BV | BV/P | |
Infosys | 137,950 | 572 | 241 | 1,583 | 6.6 | 15% |
HUL* | 15,082 | 2,178 | 7 | 220 | 31.8 | 3% |
Tata Motors | 86,975 | 386 | 226 | 412 | 1.8 | 55% |
SBI | 612,364 | 635 | 965 | 1,227 | 1.3 | 79% |
BHEL# | 110,189 | 490 | 225 | 1,460 | 6.5 | 15% |
We hope this article was able to throw some light on the concept of P/BV and its relevance from an investor's viewpoint. The ratio has its shortcomings that investors need to recognise. However, it offers an easy-to-use tool for identifying clearly under or over valued companies.
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21 Responses to "P/BV: Understanding the concept"
Nelson tay
Oct 13, 2011P/bv less than 1 mean company assets overvalue, is it is true that company assets value are true number ( not base on estimation).
Equitymaster, Do you agree If we say p/bv less than 1 mean stock price undervalue?
Muhammad Arif
Oct 11, 2011Excellent,thankyou elaborating topic in a very easiest & understanding way, but one have to know that how to collect information about a company share (P/BV ratio) for the past 5-year.
snehal
Aug 8, 2011very good article i have read too much late.
Realy nice articles. Thank u very much to increase the knowledge
But what BV/P INDICATE.
kedar
Jul 20, 2010Very good!I am totally new to market and even then it was informative.It will now help me decide about investing.
sheenq
May 4, 2010It was very informative. Very simple and very well narrated. Thank you so much
Saroj
Feb 7, 2010Too good! Thanks! I am not a new person in 'Shares'yet I was not properly understanding this P/BV ratio. Now I can utilize this ratio too,after full u/standing.
Thanks.
Nelson tay
Oct 13, 2011P/bv less than 1 mean company assets overvalue, is it is true that company assets value are true number ( not base on estimation).
Equitymaster, Do you agree If we say p/bv less than 1 mean stock price undervalue?